Rising Short Rates Unnerve Stock Funds
Fresh off the greatest month ever for stock mutual fund purchases, the $1.75-trillion fund industry is confronting the bogeyman it fears the most: rising interest rates.
Fund executives, gathering this week in Washington for their annual meeting, may feel as if they are in a roller-coaster car that just climbed to the top of the track.
In April, stock funds took in $11.6 billion in net new cash, the biggest inflow ever and a rise of about $300 million from March, the Investment Company Institute reported Tuesday. Bond fund net inflows were $10 billion in April, not a record but well above the $7.4 billion in April, 1992.
But so far in May, while stock and bond fund purchases have been respectable, they are down moderately from last month, many fund companies report.
At the same time, short-term money market funds are beginning to attract investors’ cash for the first time since last fall, as short-term interest rates creep up on inflation worries.
It doesn’t take much to grasp the potentially worrisome shift here: Some investors, sensing that interest rates have bottomed after falling almost relentlessly for three years, are moving into money market funds, possibly at the expense of stock and bond funds.
Granted, there has been no mass movement of cash from stocks to money funds. The largest mutual fund company, Boston-based Fidelity Investments, says that while new purchases of its money funds have risen in May, investors also still are buying stock and bond funds.
In other words, it isn’t as if people are abandoning stock and bond funds. So far, they just appear to be buying less of those funds, perhaps siphoning into money funds some of the cash they might otherwise have dumped into stock and bond funds.
At the Benham Group of mutual funds in Mountain View, Calif., the net inflow into money funds so far this month is $2.5 million, spokesman Seth Bernstein says. While that is a minuscule sum for a firm managing $3.8 billion in money fund assets, it is a dramatic reversal from the first four months of the year, when Benham saw $250 million flow out of money funds.
Are money funds suddenly a terrific investment? Only if you believe that a 2.6% annualized yield is a hot return. While short-term interest rates have moved up in the last few weeks, they haven’t moved up all that much. A three-month Treasury bill paid 2.87% in early May; the rate now is 3.08%.
Many fund executives believe that investors who are moving back into money funds aren’t responding so much to higher short-term rates as to the general uneasiness about the economy. Check out the latest consumer-confidence report, for example.
What’s more, “the political situation (in Washington) is not giving you a lot of reasons to feel at ease” about the country’s direction, notes Robert Schmidt, president of Dreyfus Service Corp., the New York-based fund giant.
All of this could blow over, of course. Money fund assets also rose last fall for a brief period--until investors felt better (post-election), the economy improved and interest rates resumed their decline.
The difference this time is that, while the economy should get better, short-term interest rates probably aren’t going down anymore. The Federal Reserve has virtually said as much, if we can believe the leaks from last week’s Fed policy meeting.
So that leaves stock and bond fund managers with a $1.75-trillion question: How high do short-term interest rates have to climb for investors to decide that stocks and bonds are no longer worth the risk--that you’re better off keeping your cash in a money fund or in a bank CD?
Remember: Because stock and bond funds have been responsible for fueling so much of the 2 1/2-year-long rally in those markets--allowing former savers to become investors-- any drop in cash flows into the funds could mean the twilight of bull-market mania.
Jon Fossel, head of the Oppenheimer mutual funds in New York, doesn’t quarrel with rising-rate expectations. He sees short-term rates between 4% and 4.5% by the end of this year, courtesy of an improving economy.
But he doubts that, at those rate levels, investors will lose their appetite for stocks and bonds.
Investors can do math, Fossel says: They know that a 7% yield on a bond will still beat 4.5% on a money market fund. And they know that over the long run, stocks typically return 8% to 10% a year--which also beats a 4.5% money fund yield, or even a 6% money fund yield, for that matter.
It’s true that some investors will find their own personal risk-reward equation favoring money funds as the year wears on, Fossel says. But don’t bet on a mass exodus from stock and bond funds, he says.
Are fund executives too sanguine about investors’ ability to ignore rising interest rates? Kurt Brouwer, whose San Francisco-based firm Brouwer & Janachowski manages $275 million for clients, believes Fossel is right, at least for the rest of this year.
Investors, Brouwer says, have taken a long time to become believers in stocks and bonds. Likewise, they are unlikely to walk away quickly, he says. Just as they rationalized staying in money market accounts for too long as rates dropped in recent years, they will rationalize staying in stocks and bonds in the early stretch of a rising-interest rate cycle, Brouwer figures.
In fact, there’s a very good argument that the cash now building up in money funds is just more fuel for one more bull market surge, at least in stocks.
“A movement like this takes a long time to start and a long time to stop,” Brouwer says. “Once you get a popular movement in investing, it tends to hang on to the bitter end.”
The Favorite Funds
Growth and Income stocks: $5.91
Municipal bonds: $5.42
Growth stocks: $4.70
Government Bonds: $3.29
Aggressive growth stocks: $3.00
Mixed bonds: $2.49
GNMA bonds: $2.29
Equity-income stocks: $1.95
Note: Purchases are gross figures (before redemptions) and do not include reinvested dividends.
Source: Investment Company Institute
